As a small business owner, you’ve probably wondered at some point whether you should hire a traditional employee or an independent contractor.
In this guide, we’ll go over what exactly the difference is between the two, the pros and cons of hiring both, and how to decide which one is right for you.
What’s the difference between 1099s and W-2s?
W-2s (employees) and 1099s (independent contractors) get their names from the tax forms they receive each year—the W-2 and 1099-MISC, respectively. But distinguishing between the two isn’t always easy.
Many workers these days receive both forms around tax time (anyone who makes more than $600 a year in freelancing revenue must file a 1099). And the IRS has no fixed rules that distinguish W-2 work from 1099 work. Instead, they use the following three criteria:
If you train someone, set their hours and control how they do their work, according to the IRS, they’re a W-2. But if they set their own hours and control their own work, they’re a 1099.
The IRS has more to say about behavioral control in their guidelines, but a simple rule of thumb for this is: if you’re planning on hiring a 1099, remember that only the result of their work will be under your control.
If you pay someone a salary or a guaranteed wage, they’re probably a W-2. If you pay them a flat fee per project, they’re a 1099.
1099s also have a “significant investment” in their business (they control their equipment, training and licensing) and aren’t reimbursed for fuel, tools, supplies, etc.
1099s can usually work for other companies, while W-2s often have non-compete clauses in their contracts.
Type of relationship
If the work someone does is a “key aspect of your business,” they’re probably a W-2. If the work they do isn’t core to your business, they’re probably a 1099.
If you grant someone benefits and bring them on for the long run, and expect them to work for you indefinitely, they’re a W-2. If you bring them on for the short term to complete a set amount of work, on the other hand, they’re probably a 1099.
1099s vs. W-2s: the pros and cons of hiring each
1099s are cheaper, usually
In most cases, 1099s are cheaper to hire than W-2s. You don’t have to pay 1099s health insurance, life insurance, bonuses, stock options, or 401(k) contributions. You also don’t have to pay for their training, their downtime, or their worker’s compensation.
That being said, there are situations where hiring a W-2 is cheaper. Salespeople, marketers, software developers and other independent professionals can charge high hourly fees. If the work they do is core to your business, and you’re paying them for enough hours a week, it could be cheaper to bring them in-house as a W-2.
1099s have less regulatory burden, usually
W-2s are protected by all kinds of employment laws, like the Fair Labor Standards Act (FLSA), the Occupational Safety & Health Act (OSHA) and Title VII of the Civil Rights Act. In many cases, hiring a 1099 can simply be less of a regulatory burden.
That being said, sometimes it’s the other way around.
As more companies replace W-2s with 1099s, the Department of Labor and the IRS have stepped up their efforts to crack down on “misclassification”—when employers hire and compensate someone like a 1099, but control their work like a W-2. The IRS says misclassification is a form of tax evasion, and will come after you for the unpaid employer and employee portions of payroll taxes, Social Security, and Medicare if they discover you’ve done it.
In recent years, the IRS has been known to automatically investigate the independence of 1099s that report more than $10,000 in income, using an algorithm.
And remember: just because someone works remotely, signs a contract, pays for their own office supplies and receives a 1099 form doesn’t mean they’re a 1099. According to the U.S. Department of Labor, “employers may not misclassify an employee for any reason, even if the employee agrees.”
1099s are more flexible (but you have less control)
It’s usually easier to end a relationship with a 1099, especially if you make that part of your contract. If your employment needs are unpredictable—because your business is highly seasonal, for example—it can be easier to hire 1099s.
At the same time, in some states, “at-will” policies can actually make it easier to fire a W-2 than a 1099 you’ve signed a contract with. And the fact that you control a W-2’s day-to-day work means that you have more room to change course and halt their work if you think it’s going poorly.
W-2s are better for the long-term
Because W-2s usually need to be trained and incorporated into office life, it can take a while before they’re ready to do productive work for you. 1099s, on the other hand, are used to getting started on projects right away. If you’re growing and you need immediate results, you might want to hire 1099s.
If you’re looking for results in the long run, however, W-2s are usually the way to go.
W-2 job postings tend to attract higher-quality applicants who are more willing to commit to your business for the long haul. Because they aren’t constantly looking for other work, they can also focus better on the task at hand.
If you’re looking to build a cohesive team with a robust company culture, a group of happy W-2s is usually going to be a better bet than a constellation of remote 1099s. And if your company is growing and you ever need managerial help, it’s also more useful to have a W-2 around who knows your business than it is to hire an outsider.
W-2s are better for core business work
If someone is doing work that is non-essential to your business (like graphic design, copywriting, accounting, etc.) hiring a 1099 to do it can be cheaper, quicker and less of a regulatory burden.
If the work you need done is core to your business (like marketing, client relationship management, any managerial work, etc.) hiring a W-2 to do it might make more sense from a long term, work culture perspective.
1099s vs. W-2s: a pros and cons summary
|1099s (independent contractors)||W-2s (employees)|
|Cost||Pros: Cheaper in most cases, because you don’t have to pay them benefits.
Cons: High hourly cost.
|Pros: Sometimes cheaper, especially if you’re paying them to work full time.
Cons: More expensive in most cases.
|Regulation||Pros: Less regulated by federal employment law.
Cons: Heavy penalties if you misclassify a 1099.
|Pros: No risk of misclassification.
Cons: More protected by federal employment law.
|Flexibility||Pros: Easier to end relationship, better for unpredictable/seasonal work.
Cons: Less control over short-term work.
|Pros: Easier to control work on a day-to-day basis.
Cons: Harder to fire if protected by employment law.
|Short term/long term results||Pros: Can start work immediately.
Cons: Might not be as loyal/committed in long run.
|Pros: More focused, dedicated in long run.
Cons: Need time to get trained.
|Work function||Pros: Better for work that isn’t core to business.
Cons: Might be too expensive for core work in long run.
|Pros: Better for work that is core to your business.
Cons: Too expensive if the work is temporary or not core to your business.
How to figure out who you should hire
Calculate how many hours you need them to work every week
Different organizations have different definitions of what it means to work for someone “full-time.” The IRS says it’s anyone who works for you more than 30 hours a week, whereas the U.S. Bureau of Labor Statistics says it’s anything above 34 hours. Generally speaking, if you need someone to be around for more than 30 hours a week, you should hire them as a W-2.
On the other hand, if you know that the position you’re hiring for isn’t a long-term one (i.e. a few months or less), you should hire a 1099.
Calculate how much you can spend on them
Once you’ve decided how long you need to keep them around for, you need to figure out how much you’re willing to pay them.
1099s can sometimes charge you more per hour than W-2s, but if you’re keeping them around for a while, a W-2’s benefits can add up.
Hiring a 1099 at an hourly rate, a 1099 at a flat per-project rate, and a W-2 at an hourly rate can each end up being cheaper if the circumstances are right. Figure out how much each option will cost you, and pick the least expensive one.
Decide whether they need to be in the office
Once you’ve figured out their time commitment and rate, you have one more factor to worry about: will this person work best remotely or working with you in-person?
If you think the position you’re hiring for lends itself better to remote work—because it isn’t core to your business, and doesn’t require the worker to meet/collaborate with other employees—hire a 1099.
If the work is collaborative, however, or related to your core business in some other way, it might be worth hiring them as a W-2, at least on a temporary basis.